Reference no: EM13911153

Better Care Clinic (Breakeven Analysis) Fairbanks Memorial Hospital, an acute care hospital with 300 beds and 160 staff physicians, is one of 75 hospitals owned and operated by Health Services of America, a for-profit, publicly owned company. Although there are two other acute care hospitals serving the same general population, Fairbanks historically has been highly profitable because of its well-appointed facilities, fine medical staff, and reputation for quality care. In addition to inpatient services, Fairbanks operates an emergency room within the hospital complex and a stand-alone walk-in clinic, the Better Care Clinic, located about two miles from the hospital.

Todd Greene, Fairbanks’s chief executive officer (CEO), is concerned about Better Care Clinic’s financial performance. About ten years ago, all three area hospitals jumped onto the walk-in-clinic bandwagon, and within a short time, there were five such clinics scattered around the city. Now, only three are left, and none of them appears to be a big money maker. Todd wonders whether Fairbanks should continue to operate its clinic or close it down. The clinic is currently handling a patient load of 45 visits per day, but it has the physical capacity to handle more visits—up to 60 per day. Todd has asked Jane Adams, Fairbanks’s chief financial officer, to look into the whole matter of the walk-in clinic. In their meeting, Todd stated that he visualizes two potential outcomes for the clinic: (1) the clinic could be closed or (2) the clinic could continue to operate as is. As a starting point for the analysis, Jane has collected the most recent historical financial and operating data for the clinic, which are summarized in Table 1. In assessing the historical data, Jane noted that one competing clinic had recently (December 2008) closed its doors.

Furthermore, a review of several years of financial data revealed that the Fairbanks clinic does not have a pronounced seasonal utilization pattern. Next, Jane met several times with the clinic’s director. The primary purpose of the meetings was to estimate the additional costs that would have to be borne if clinic volume rose above the current January/February average level of 45 visits per day. Any incremental volume would require additional expenditures for administrative and medical supplies, estimated to be $4.00 per patient visit for medical supplies, such as tongue blades, rubber gloves, bandages, and so on, and $1.00 per patient visit for administrative supplies, such as file folders and clinical record sheets.

Although the clinic has the physical capacity to handle 60 visits per day, it does not have staffing to support that volume. In fact, if the number of visits increased by 11 per day, another part-time nurse and physician would have to be added to the clinic’s staff. The incremental costs associated with increased volume are summarized in Table 2. Jane also learned that the building is leased on a long-term basis. Fairbanks could cancel the lease, but the lease contract calls for a cancellation penalty of three months’ rent, or $37,500, at the current lease rate.

In addition, Jane was startled to read in the newspaper that Baptist Hospital, Fairbanks’s major competitor, had just bought the city’s largest primary care group practice, and Baptist’s CEO was quoted as saying that more group practice acquisitions are planned. Jane wondered whether Baptist’s actions should influence the decision regarding the clinic’s fate. Finally, in earlier conversations, Todd also wondered whether the clinic could “inflate” its way to profitability; that is, if volume remained at its current level, could the clinic be expected to become profitable in, say, five years, solely because of inflationary increases in revenues? Overall, Jane must consider all relevant factors—both quantitative and qualitative—and come up with a reasonable recommendation regarding the future of the clinic.

Table 1

Better Care Clinic Historical Financial Data

Daily Averages

CY

2008 Jan/Feb 2009

Number of visits 41 45

Net revenue $1,524 $1,845

Salaries and wages $428 $451

Physician fees 533 600

Malpractice insurance 87 107

Travel and education 15 0

General insurance 22 28

Utilities 41 36

Equipment leases 4 5

Building lease 400 417

Other operating expenses 288 300

Total operating expenses 1818 1944

Net profit (loss) ($294) ($99)

Table 2

Better Care Clinic Incremental Cost Data

Variable Costs:

Medical supplies $4.00 per visit

Administrative supplies $1.00

Total variable costs $5.00 per visit

Semi-fixed Costs:

Salaries and wages $100

Physician Fees $267

Total daily semi-fixed costs $367

Note: The semi-fixed costs are daily costs that apply when volume increases by 11–20 visits. However, the physical capacity of the clinic is only 60 visits per day

Question: Suppose you just found out that the $3,215 monthly malpractice insurance charge is based on an accounting allocation scheme that divides the hospital’s total annual malpractice insurance costs by the total annual number of inpatient days and outpatient visits to obtain a per-episode charge. Then, the per-episode value is multiplied by each department's projected number of patient days or outpatient visits to obtain each department's malpractice cost allocation. What impact does this allocation scheme have on the clinic’s true (cash) profitability? (No calculations are necessary).